With all its negative connotations, many business owners hesitate to file for bankruptcy. But when business debts are piling up, and it seems there’s no way out, bankruptcy might be the only way to protect the business’s assets.
But can a business file for bankruptcy and stay open? The answer might surprise you – here’s what you need to know.
Can a Business File For Bankruptcy and Stay Open?
Yes. In fact, the primary purpose of certain types of bankruptcy is to keep a business operating during and after filing for bankruptcy. As in the case when a company files Chapter 11, Chapter 11 Subchapter 5, or Chapter 12 Bankruptcy. These chapters allow the business to reorganize rather than liquidate – we’ll dive more into this.
What Does Filing Bankruptcy Mean, Then?
Filing bankruptcy doesn’t mean an automatic dissolution of a business. So, what does it mean?
When a business desires to stay open and files for bankruptcy protection, it usually means it is seeking legal protection from its creditors. This typically happens when either a company's liabilities exceed its assets and creditors are unwilling to work out a reasonable restructuring of those liabilities, or it cannot generate enough revenue to cover its expenses in a timely manner.
The primary goal of bankruptcy is to help a struggling business regain financial stability while protecting its stakeholders, including its employees, vendors, creditors, and owners.
Types of Bankruptcy When a Business Can Remain Open
The United States Bankruptcy Code provides three types of bankruptcies specifically for businesses that allow them to stay open: Chapter 11, Chapter 11 Subchapter 5, or Chapter 12 Bankruptcy.
Chapter 11 Bankruptcy
Chapter 11 Bankruptcy is commonly referred to as “reorganization bankruptcy” for medium to large businesses. It allows a business to restructure its finances and operations while remaining open. It’s often used by companies struggling with debt and financial problems wanting to stay open and avoid liquidation. Typically, debts are paid back over several years, and some are discharged. Expect repayment plans to last between five and ten years.
The business will create a plan to restructure its debt and operations and present it to the court and creditors. The plan typically includes proposals to reduce debt, renegotiate leases and contracts, and restructure the company's operations to become more profitable. One of the most significant differences between a traditional Chapter 11 and a Chapter 11 Subchapter 5 Bankruptcy (which we’ll cover in the next section), is the formation of a creditors' committee, which can put forth a competing reorganization plan.
During the Chapter 11 Bankruptcy process, the business is protected from most collection actions by its creditors, such as lawsuits and foreclosure. This allows the company to focus on restructuring its operations without being distracted by legal disputes. Once the plan is approved, the business exits the formal bankruptcy process and continues operations under the reorganization plan.
Chapter 11 Subchapter 5 Bankruptcy
Subchapter 5 lives under Chapter 11 Bankruptcy. This type of Chapter 11 is known as the small to medium business “reorganization” bankruptcy, after Subchapter 5 was added to make a reorganization bankruptcy more accessible to smaller businesses.
While relatively new (introduced in 2020), Subchapter 5 has become an essential resource for small businesses who have been hit hard over the past few years. With this option, the company in debt can reorganize its debt and develop a plan to pay off the remaining debt without shutting down operations.
One of the best features of Subchapter 5 Bankruptcy is that it allows business owners to use the process to cram down secured debt, challenge, or break UCC liens, and greatly reduce or completely shed unsecured debt. They also don’t need to get approval for their plan from creditors.
Note: What does cramdown mean? A cramdown is a term used when a court disregards creditor protests and gives consent to a debtor's plans for restructuring, provided that the plan is deemed reasonable. In cases where the court approves the reorganization plan, but a creditor opposes it, the court may compel the creditors to comply with the provisions, known as a "cramdown."
The main differences between a standard Chapter 11 Bankruptcy and Subchapter 5 Bankruptcy are complexity and control. Subchapter 5 is streamlined, faster, has reduced legal complexity, eliminates personal disclosure, and is less expensive than Chapter 11. Plus, Subchapter 5 puts business owners in the driver’s seat, since they get to keep their equity, primary control and are the only party who can submit a debt restructuring plan.
During the Chapter 11 Subchapter 5 Bankruptcy process, a business is safeguarded from most creditor collection actions, such as lawsuits and foreclosure. This protects the company from legal disputes, allowing it to concentrate on revamping its operations. Once the restructuring plan is sanctioned, the business exits the formal bankruptcy process and carries on with operations under the reorganization plan, while keeping control and equity.
Chapter 12 Bankruptcy
Chapter 12 Bankruptcy is exclusively for farms and fisheries, allowing owners to restructure finances while keeping ownership of their assets. The business works with a trustee and creditors to create payment plans lasting 3–5 years, with specific debt levels that change based on the economy and commodity prices.
The process is similar to Chapter 11, with a petition filed, court-supervised meetings with creditors, and business assets used to repay debt. Chapter 12 also includes an automatic stay provision for consumer debt to prevent creditors from collecting.
What About Chapter 13 Bankruptcy?
If you’ve done your own research regarding bankruptcy, you might have come across mentions of Chapter 13 Bankruptcy. It’s important to note that Chapter 13 is a type of personal bankruptcy, not business bankruptcy.
However, if the business is not a separate entity (ex. LLC), but instead a sole proprietor (an individual using a DBA), it can be used to handle personal and business debts.
Considering Bankruptcy? Talk with The Lane Law Firm
When a business must file for bankruptcy, knowing all available options is essential. Our business bankruptcy attorneys at The Lane Law Firm can help. Our team has helped companies to reduce their debt by up to 70% and get back on track. Get in touch with our team and explore business debt relief options today.
